European corporate default rates are expected to fall modestly during 2011, but may rise again from 2012 in the face of economic headwinds and refinancing challenges, according to Standard & Poor’s (S&P) Annual European Corporate Credit Outlook.
The trailing 12-month European speculative-grade default rate – derived from S&P’s universe of 726 private credit estimates and publicly rated corporate entities – was 5.9% at the end of September 2010, down from a peak of 14.8% at the end of 3Q09. The default rate is expected to fall to about 4% by the end of 2010, taking it to below its long term 4.3% average for the first time since the 4Q08, and to fall slightly further to 3.8% by the end of 2011. This would equate to 27 European companies with speculative-grade credit ratings or private credit estimates defaulting during 2011.
“Corporate default rates in Europe should remain relatively low in 2011, but we think this will mark only a temporary respite,” said Blaise Ganguin, S&P chief credit officer for Europe.
Likely more restrictive monetary policy and growing refinancing risks could precipitate a resurgence of defaults in 2012 and 2013, mainly among leveraged buyouts (LBOs) that were launched between 2006 and 2008, driving the default rate to 6.5% or even slightly higher in 2012. These companies face major challenges refinancing about €230bn of debt maturing before 2016. They will be competing with about €16 trillion of debt issuance expected from corporate and sovereign borrowers over the same period, at a time when the economy may be feeling the effects of tighter monetary and fiscal policy, anaemic consumption and limited lending capacity by banks.
The report, titled ‘Credit Quality Among European Corporates Is On A Positive Track For 2011, Less So For Banks’, outlines S&P’s predictions for credit quality in the European banking, corporate, insurance and leveraged finance sectors in 2011. It notes that while most sectors will benefit from stabilising and even improving business outlooks next year, sovereigns, banks and to a lesser degree insurance companies could see their credit quality erode further.
Key expectations include:
- Reduced credit risk among European speculative-grade rated issuers, with up to 27 companies likely to default by the end of 2011 in S&P’s base-case scenario equivalent to a default rate of 3.8%. By comparison, in the year to end September 2010, 24 defaults had been recorded, affecting €17.0bn of outstanding funded debt and for full-year 2009 103 defaulters on €62.4bn of debt. Currently, S&P considers 11 publicly rated companies in Europe to be ‘weakest links’, most vulnerable to default. This is lower than the 20 issuers designated as weakest links at the same time in 2009.
- Among European nonfinancial companies, the overall number of rating actions has started to slow, reflecting a more stable operating environment. Rating upgrades started to outpace downgrades in the 3Q10, and S&P expects this improvement in corporate credit quality to continue. Sectors that S&P anticipates may suffer weak business conditions in 2011 include the utilities, steel and downstream oil and gas sectors. Very low short-term interest rates for the time being continue to enable lenders to take a pragmatic approach to supporting the high proportion of companies that still have over-levered balance sheets.
- In the European banking sector, high rates of nonperforming loans, the transition to increased capital and liquidity requirements, and more expensive funding could limit lending capacity and in turn constrain investment. Although the position of various European banks appears to be stabilising, S&P believes many face increasingly tricky strategic and commercial challenges. This is reflected in the high (one-third) proportion of negative outlooks and CreditWatch negative placements. Funding still constitutes a pressure point for the region’s banking system overall, and European banks will have to refinance over €2 trillion of debt by 2015. Despite a greater industry awareness of funding risks, many banks have increased their reliance on short-term funding over the past three years.
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